Real-world Development with propertyCEO – Part 7
Small-scale property development projects that use permitted development rights can be done in your spare time, boast six-figure returns, and have a lower cost of entry than buy-to-lets. It all sounds great on paper, but what’s it REALLY like to convert a property?
Join Ritchie Clapson CEng MIStructE, veteran developer, author, commentator, and co-founder of development training company propertyCEO, as he guides us through a real-life commercial conversion project from start to finish. Witness the highs and the lows, and learn the critical takeaways in this eye-opening, warts-and-all look at what REALLY happens where property development theory stops and the practice begins
You can watch a video of Ritchie walking around the project. Click HERE for exclusive video content.
The story so far…
Despite a few bumps in the road, Ritchie’s five-flat commercial conversion project seemed to be in good shape, particularly now that his contractor’s tender pricing meant he should still make a decent margin. Now it was time to refocus on the finance side of the project. Ritchie had previously been given a decision in principle from the commercial lender, who would be providing 100% of the money needed to develop the building. But before any formal agreement could occur, the lender would need to conduct detailed checks on Ritchie and the project to ensure they were happy with the deal. If they weren’t, then not only could they make the finance costs prohibitive, but they could potentially walk away altogether…
Development finance often raises a few eyebrows with new developers. Some can’t quite believe that a commercial lender will lend them ALL the money they need to pay for their project’s construction, fees, and finance costs without them putting in a penny of their own. The truth is that the same lender already has a first charge on the building or land, and every brick that gets laid adds to the site’s value. So, their risk is minimised, and the more they lend, the more they earn.
Many lenders work through a broker network, which is massively convenient since they’ll find you the money, meaning you don’t have to. And no money equals no fees for the broker, so there’s no cost until you get the finance sorted. On this project, we’d reached a critical stage. We’d done our ‘homework’, knew exactly what we wanted to do with the property, and had detailed budget costings from the contractor (we could also have got these from a cost consultant/quality surveyor). We also knew what we expected the units to sell for, having done some research and spoken to agents. Having the lender’s original decision in principle was great, but I now needed to know if they would lend me the money we required for this specific project. I called the broker and told him we were looking to move forward. He sent me the lender’s application form, which I duly completed and returned with my ‘homework’, hopefully giving the lender confidence that I understood the project thoroughly.
Lenders use third-party surveyors to appraise development sites, and once they’ve visited the site and submitted their report to the lender, there’s not much you can do to change it. A lender would be taking a big risk if they went against the surveyor’s findings. Luckily, I’ve learned a few tricks that generally give me the best chance of getting the highest valuation. The first is to meet the surveyor in person. I make a point of showing them around the site and explaining exactly what I’m looking to do.
* Top Tip: Make sure you talk with confidence when speaking to the surveyor – you need to be seen to know your scheme inside out.
The surveyor may be from out of town, and I could be just one of several visits they’re doing that day. So, I also make a point of making their visit as pleasant and easy as possible.
* Top Tip: Reserve a parking space outside your building for the surveyor— move your own car if necessary. The last thing you want is a grumpy surveyor who’s had to park half a mile away and walk to your site.
Surveyors use various industry data sources to value your end units, and out-of-towners will have no local knowledge. This can be a challenge if the local area you’re building in has both ‘good’ and ‘bad’ parts, where valuations vary significantly from one street to the next. You don’t want the surveyor to use generic data that lumps your project in with the dross, so explain this to them and include it in your own assessment report, which you should give to them.
* Top Tip: Don’t ask the surveyor if they’d like to see your own assessment of the GDV valuation – they’re not allowed to use it. Instead, just hand it to them. They’ll take it and will almost certainly read it before they make their report.
Our surveyor seemed personable enough and, having used my parking space, he left for his next assignment with my own valuation report in his bag.
* Top Tip: Get local estate agents to give you a written estimate of the value of your units and give these to the surveyor too. They’re influential because they’re from a third party, but make sure you have at least three estimates to demonstrate the figures are robust.
The lender will consider numerous factors besides the surveyor’s report, including flood risk, the building’s structure, and contamination risk. They’ll also examine the planning history to confirm what permissions have been granted.
* Top Tip: Never imply you’ve got planning permission when you haven’t – the lender will always check to determine the actual position.
They’ll also conduct various sensitivity analyses to stress the deal, e.g. what if the GDV slumps, construction costs rise, or the contractor goes bust. The surveyor will use the Building Cost Information Service (BCIS) to determine the construction costs for your project, which, in our case, proved problematic. Their estimate came in at £45k too high, impacting the profitability and, therefore, the amount they would lend. Fortunately, I had already negotiated a lower price with my contractor, so I could argue that this quote should be the basis of their estimate. After some negotiation with the lender, they eventually agreed.
* Top Tip: Personally stress test your own deal. It’s your business, and you need to understand how sensitive your deals are to events outside your control which could affect your bottom line.
Before they sent me the offer, the lender asked me to update my Assets and Liabilities Statement, which sets out the net worth of the individuals running the development – in this case myself and the building’s owner who I was joint venturing with.
* Top Tip: It’s well worth maintaining an up-to-date version of your Assets and Liabilities Statement – you never know when you’ll be asked for it, and it will save time.
A few days later, my broker rang to confirm that the funding offer document had been released. As soon as it landed, I immediately forwarded it to Peter, my solicitor, and also read it from cover to cover. It was a dry read, but while Peter could pick through the legalese, he didn’t know the deal in detail. I’d be on the hook if anything were incorrect, so I needed to review it thoroughly.
* Top Tip: Have your solicitor primed and ready to go so they can get cracking on the offer document as soon as it comes in. You’ll have a response deadline from the lender and don’t want to miss it because your legal team is too busy.
The offer document covers all the critical elements of the loan. How much they’d lend, at what rate, and over what timescale were the headlines, but it’s the penalty clauses for overruns and additional fees that can catch you out if you’re not careful.
* Top Tip: Never choose a commercial lender based on its headline interest rate alone. Before comparing, add in all the associated fees (drawdown surveys, repayment fees, penalty charges, etc.) to arrive at an overall cost.
A week later, Peter called to say he’d been through the documentation and was ready to meet. Together, we spent several hours going through the offer document line by line, which allowed me to ask lots of stupid questions.
* Top Tip: Always ask questions about the contract if you don’t understand something. Never assume that just because a clause looks like standard legalese, you shouldn’t question it. You’re the one who’ll be affected if it’s problematic, so never be too embarrassed to ask.
One of the other documents the lender had sent me was a personal guarantee (PG) that they needed me and the building’s owner (my joint venture partner) to sign. This required me to find an independent solicitor (not Peter) to advise me on it to ensure I understood we would both be joint and severally liable, which I did.
While the money would be lent to a special purpose vehicle or SPV – a new limited company set up for the project – my JV partner and I would both be personally liable if something went wrong and there wasn’t enough money to cover the debt.
* Top Tip: If you have a JV partner, your PGs will make you jointly and severally liable. This means the lender can pursue just one of you for any monies owed, even if you owe jointly. If you have more liquid assets than your partner, they’ll likely go after you. So, make sure you check out your partner’s finances before you enter a JV relationship, and get confident that they won’t head for Mexico if the going gets tough, leaving you in the hot seat.
Following my meeting with Peter, I had a few questions, which I cleared up with the broker before I signed on the dotted line and scanned the documents back to him.
* Top Tip: Your lender may also require you to sign a debenture for your SPV, which prevents it from borrowing additional money without the lender’s approval.
I now had access to all the money I needed to develop the project, around £300,000, which meant we could now get cracking. This is always a satisfying moment. Everything up to that point had been about making plans and getting things in place, with many associated ups and downs. But now that the funding was approved, it meant we could start making things happen. My next call was to the architect to tell him he would be in for a busy few weeks.